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Be the Sith Lord

The market's far too optimistic about stocks. You can help keep it real.

Never a cloudWall Street is way too sunny. Always has been. Always will be. Little has changed since the days when Thornton O'Glove suggested, in Quality of Earnings, that we can't trust the analysts, and we sure can't trust the auditors. (The examples of Enron, WorldCom, and others provide ample proof.)

But we can trust the market, right? Even in the worst cases of public delusion, there are a few forward-looking Cassandras out there telling people that doom approaches. Surely their work and sentiment will be reflected in the price?

A conspiracy of smilesUnder ideal circumstances, a market price for a stock will reflect the sum total of information and sentiment on that stock. But if analysts lay off a stock because it means fewer holiday-party invites to the Hamptons, there's an information imbalance. If critics clam up because a raging, lawsuit-happy CEO like Overstock.com's (NASDAQ:OSTK) Patrick Byrne comes gunning for them as tools of the miscreant "Sith Lord," there's a further chilling effect.

If a CEO tries to prop up the stock via manipulative means, as with the warrant scheme or (recently recanted) insider "buying" at Pegasus Wireless(NASDAQ:PGWC), there's another market imbalance.

Finally, securities regulations, brokerage policies, and the demand for short shares also conspire to keep prices too high, especially on companies that need shorting in the worst way. For instance, I, and many of my colleagues, would love to have been able to short Overstock or Pegasus 50-odd percent ago. But borrows were in short supply. My broker couldn't get them at all, and if it could, I'd have been asked to pony up a hefty rebate just to take the position.

Clearly, charging a higher-than-market rate for the opportunity to short stocks (rather than buy) reduces the downward pressure on a stock, which is just another way of saying the share price remains overinflated. That's just how the system works.

It ain't easy being a Sith Lord.

Until now.

There's not much we can do to change the way the market conspires to fluff up the prices of lousy companies, but there is a new way to capture bearish sentiment on stocks. It's a system we call Motley Fool CAPS.

It ain't the Death Star, but it'll do.CAPS isn't like Wall Street. First off, it doesn't cost anything to play in this virtual market. But the mechanics are a lot different from the usual online portfolio stuff you've seen out there. You simply decide whether or not the stock will outperform the market, or underperform, and go.

This makes it a great place to get your Sith on.

There's no transaction cost for shorting a stock in our virtual market. There's no uptick rule. There's no rebate. There's no shortage of shares. Simply drop in, tell everyone why you think NVE(NASDAQ:NVEC) is an overhyped non-player in the non-existent MRAM market, and give it a thumbs down.

That's not allBut here's the best part.

CAPS is intelligent, and it's adaptive. Unlike the market, which simply moves with supply and demand, CAPS knows smart money from dumb dough. Stocks are rated not simply by the number of thumbs up or thumbs down, but by the quality of the player waggling the digit. CAPS keeps track of how good you are as a stock picker -- you and everyone else -- and weighs your calls accordingly.

That's why Apple(NASDAQ:AAPL) can have a CAPS rating of only two stars, even though bulls outnumber bears by a 5-to-1 margin. It's why iRobot(NASDAQ:IRBT) is worth only three stars despite the 8-to-1 bullish sentiment. It's why FedEx(NYSE:FDX) can't quite break into five-star territory, despite a 31-to-1 bullish sentiment ratio.

Sithishbottom lineAlas, potential Sith Lords do face a few constraints. CAPS won't let you rate companies with share prices below $1.50, or market caps below $100 million. So folks interested in the likes of GlobeTel(AMEX:GTE) or Xethanol(AMEX:XNL) are out of luck for now. But, hey, there's always the next press release, right?

Aspiring Sith Lords -- and little Suzie Sunshines -- can both get in on the action. Think you know which way a stock is moving? Join CAPS for free, and put your virtual money where your mouth is. May the force be with you.

iRobot is a Motley Fool Rule Breakers pick, and Overstock is a former pick of the same newsletter.

At the time of publication, Sith Jayson had no positions in any company mentioned here and was rated above the 99th percentile in CAPS, mostly by shorting. View his stock holdings and Fool profile here. See what he's Digging these days. Fool rules are here